Global Investing Hot Spots

The $2.4 trillion companies are keeping in overseas tax havens

Apple CEO Tim Cook dismissed the EU decision to levy billions in back taxes on the tech giant's Irish operations as "political crap." Cook could be right, but not for the reason he thinks, or a reason that would offer stock investors much comfort.

If overseas tax authorities don't target more offshore cash hoards, Apple may have a point that the target seems to be on its back. What could prove the Apple CEO right is the $2.4 trillion that more than 300 of the Fortune 500 companies keep in overseas tax havens.

If global tax authorities come after more of the massive global cash stockpile, investors in many popular stocks will face a risk to profits they have long been taking for granted.

A customer enters the new Apple store in Covent Gardens, London.
Suzanne Plunkett | Reuters

The $2.4 trillion estimate comes from Citizens for Tax Justice (CTJ), a watchdog group that has been critical of the corporate use of tax havens. It's not science, but that's not the fault of the nonprofit: The disclosure from corporations over use of offshore tax havens is extremely limited.

Matt Gardner, executive director of the Institute on Taxation and Economic Policy, a partner organization to CTJ, has done the work of searching through corporate filings for the tax information. The limited disclosure in 10-K filings that is now available requires public companies to list their overseas subsidiaries and how much of their cash has been reinvested abroad. That level of disclosure took a permanent subcommittee in 2013 to make it happen, and Gardner said, "It tells you nothing at all about how the money is invested, whether it is sitting under a bed or whatever."

Within the group of 303 Fortune 500 companies that disclose this information, roughly one-sixth disclose whether they paid tax paid on profits. The Securities and Exchange Commission only requires a company reveal how much they would pay upon repatriation of assets or indicate that "it's too hard to figure out," Gardner said. Yet he added that the SEC is growing more skeptical of this free pass and that is one reason he thinks more Fortune 500 companies are estimating tax liability.

Fifty-five companies in that group of 303 go the extra step of estimating what they would pay in taxes upon repatriation. Of those, CTJ estimates that 27 are "likely holding a substantial amount of profits in tax havens," Gardner said. Apple discloses an implied tax rate of 30 percent. The CTJ reached this conclusion because these 27 companies disclose they would pay 25 percent or more on repatriation, implying they have paid 10 percent or less so far. "We are arbitrarily asserting that an aggregate foreign tax rate south of 10 percent means that a large chunk of these profits must be in tax havens," he said.

Corporations that upped offshore profits by $5 billion or more

Company 2015 unrepatriated income ($M) 2014 unrepatriated income ($M) Change
Gilead Sciences28,50015,60012,900
Cisco Systems58,00052,7005,300
Sealed Air5,10005,100

(Source: Citizens for Tax Justice)

There are some companies that would likely pay next to nothing upon repatriation, because they pay high tax rates overseas. Gardner gave as an example oil and gas companies doing business in Scandinavian countries and subject to tax rates overseas as high as 35 percent. But it's the other end of the spectrum, like Apple, which indicate they would pay close to 35 percent, which is "itself an indication of how little tax you paid," Gardner said.

The flip side of the argument is that the real problem is the U.S. corporate tax code. "The public behavior of the Apple CEO again and again is, 'We will bring it back when you fix the tax code."

Ireland is not even the biggest part of the tax haven picture. Using Internal Revenue Service data, CTJ found that American companies keep a majority of profits in 10 tax havens. In some cases, U.S companies are reporting subsidiaries in tax havens with cash hoards that dwarf the nations' GDP. U.S. company subsidiaries reported earning $46 billion in the Cayman Islands in the most recent year for which data is available. The problem: The GDP of the Cayman Islands is $3 billion.

Ireland is more reasonable by contrast, with U.S. multinationals reporting $135 billion in profits within an Irish economy that is $225 billion.

"Apple is one of the biggest and most profitable and has a bigger stash of offshore cash than almost anybody. But Apple is not alone," Gardner said.

Gardner conceded that "in all of these cases, it's smoke not fire," but that is due to the fact that disclosures are so limited. "For the 200-plus companies that don't disclose tax on repatriation, it's totally possible that some or even all of this cash has really been reinvested in meaningful ways in these countries. I doubt it very much, but it's totally possible," Gardner said. He said it is more likely for companies that have a substantial overseas retail presence, which requires store construction, and the same goes for manufacturing facilities.

Ireland debates Apple tax payment

Jon Lukomnik, head of the Investor Responsibility Research Center, which works with boards of directors, said that the EU decision against Apple covers multiple years, so it is not just about this year's rate or next year's rate but also about retained earnings and liabilities on the balance statement.

Even with limited disclosures, Lukomnik said investors can monitor another sign that would indicate company concern about its current overseas tax practice.

In the wake of the Apple decision, many companies are going to have to reexamine the reserves they hold to see if they need to increase them, as well as improve disclosure of potential EU tax liabilities, Lukomnik said.

"I believe the standard on tax reserving is whether the entity is more likely than not to be correct in its tax treatment. Given the EU move against Apple, and really against Ireland and therefore any of the individual nations that make up the EU, the border of where 'more likely than not' is has moved," he said. "If the reserves go up, it may mean the audit committee has determined the tax rate used over the past few years was understated, which would be a signal to equity investors that the tax rate may go up this year or next," he added.

Apple is one of the biggest and most profitable and has a bigger stash of offshore cash than almost anybody. But Apple is not alone.
Matt Gardner
executive director of the Institute on Taxation and Economic Policy

How good are your profits?

Investors do not need to get lost in the tax weeds to understand the significance of the ballooning overseas tax strategies. Ultimately, it can indicate the reliability of a company's source of profits and stock appreciation. "I immediately thought of how Apple has almost all of its cash outside of the U.S. and how it spent about $100 billion on stock buybacks. How'd that massive buyback work out for shareholders? Not too well," said Mitch Goldberg, president of investment firm ClientFirst Strategy.

During the post-financial crash extended bull market, many investors have expressed concern that stock values have been inflated by multiple forms of financial engineering: central banking policy inflating asset values and stock buybacks. Tax avoidance could be another underappreciated non-financial trigger for stock market gains in recent years.

"Not that companies trying to maximize profits is necessarily a bad thing, but rightly or wrongly, investors have given companies a pass on overseas tax 'avoidance,' which is a phrase that is quickly morphing into tax 'evasion,'" Goldberg said.

"This goes beyond the effects of corporate tax rates and repatriation of overseas cash," Goldberg said. "No doubt, corporate profits are higher because of this, and now maybe the reported net income will have to have an additional footnote. And we all could agree that we don't like footnotes, because they indicate that there is something opaque about them, or at the very least, they indicate added complexity to understanding the real bottom line of a company. ... This Apple issue just made overseas cash and tax rates a valuation issue," he added.

Average investors shouldn't expect much of a push from the institutional investing heavyweights that can use their stakes in company stock to influence policy at major corporations. A spokeswoman for the Council of Institutional Investors said the overseas tax-haven issue is not one that the council has a formal opinion on for a simple reason: its membership remains divided.

All of its union plans oppose the use of offshore tax havens, because they see it as part of the larger domestic issue of lost jobs. Other institutional investors take the disinterested shareholder view that if it helps the company's bottom line, it is justified. "We've always been a big advocate for disclosure in every area, but we haven't specifically addressed that. ... Our members not united on it," the spokeswoman said.

"Investors can ask sensible questions about this and the non-disclosure," Gardner said. "If you're building a business around tax avoidance you don't really have a business plan. If it appears to investors that companies are putting money in places basically for tax reasons that should be a matter of concern."